Cardinal Health, losing 21% of its business, has 'prepared strategies to mitigate the impact of a Walgreens nonrenewal'

Movements of supply contracts on a scale of small nations’ budgets is an entertaining sport for Wall Street analysts, but there appears to be a lot more to the announcement that Walgreens business, worth $28 billion, is moving from Cardinal Health to AmerisourceBergen. The contract is for 10 years, considerably longer than the usual 3- or 5-year deals. The country’s No. 1 retail pharmacy (by number of stores) is in a multi-year agreement to acquire UK-based Alliance Boots outright (it currently owns 45%), and the two have formed a j.v., Walgreens Boots Alliance Development GmbH, that enables the two organizations to supply each other products globally. Most eye-catching of all: the two companies will purchase a 7% equity stake in ABC, and will have warrants to purchase an additional 16% by September 2017. At two different points when and if these equity positions increase, both will have members on the ABC board. Prior to the ABC announcement, Walgreens-Alliance Boots projected combined revenue of $130 billion in 2016; adding ABC’s expected revenue in 2013 would create a $214-billion behemoth, if all three entities were united.

“As we all recognize the imperatives of health reform not only here in the U.S. but also globally, we have entered into a unique opportunity to unlock value in the pharmaceutical supply chain by collaborating to leverage all of our proven strengths,” said Steven Collis, ABC CEO. “This new relationship will significantly strengthen and grow our core business and increase our ability to deliver innovative solutions to our customers, and long-term benefits to all of our stakeholders. Importantly, these agreements not only expand our U.S. business, but also provide opportunities to meaningfully grow our specialty and manufacturer services businesses internationally.”

“This agreement with AmerisourceBergen, which we consider to be the best-positioned pharmaceutical wholesaler in North America, is a promising development for Walgreens and Alliance Boots following the formation of our strategic partnership last year,” said Stefano Pessina, executive chairman of Alliance Boots. “We strongly believe that our new partnership with AmerisourceBergen will deliver long-term shareholder value by creating an unmatched network of companies that is well positioned to anticipate increasing market needs and expectations across the world.”

ABC has already been handling Walgreen’s specialty pharmaceutical supply. The companies’ public announcement indicates that ABC will handle both branded pharmacueitcals (which Walgreens has purchased from multiple distributors) and generics, which Walgreens has self-distributed. ABC also says that it will “cooperatively work with Walgreens and Alliance Boots to provide manufacturers with integrated solutions for global clinical trial logistics and innovative global third party logistics services by leveraging World Courier’s position as a global leader in premium logistics. In addition, Alliance Boots’ growing specialty activities with European biotech manufacturers and AmerisourceBergen’s pharmaceutical product commercialization and patient support services offer manufacturers unique opportunities to expand patient access to biotech products in Europe and beyond.”

Cardinal’s public statement stated that the company expects no significant change to its 2014 guidance, with chairman George Barrett saying that “we will target a 2014 non-GAAP diluted earnings per share from continuing operations to be at least similar to the fiscal year 2013 guidance range…” Cardinal’s fiscal year ends June 30, so the end of the contract, on Aug. 31, does not affect this year’s earnings. Cardinal also noted that 60% of its Walgreen business was in bulk sales, which have minuscule 0.2% margins. In 2012, Cardinal had also lost the Express Scripts PBM business to ABC. (And, ironically, ABC’s handling of Express Scripts brings in the company Walgreens had a very public spat over during 2012 when Walgreens tried to opt out of Express Script’s pharmacy network, but eventually agreed to stay within.)

One industry sector that will look on this deal critically is generic manufacturers, who are seeing two and possibly three of their larger customers becoming essentially one buyer. Another is independent pharmacies (who compete with Walgreen); over the years, ABC has retained a strong and loyal base among independents. In Europe, Alliance Boots has been a strong combined retail pharmacy and drug wholesaler.